Magnetar Goes Long Ohio Town While Shorting Its Tax Base

Private-equity firms and hedge funds have bought as many as 200,000 homes across the U.S., typically in areas hardest hit by the housing crash, to profit from soaring demand for rentals. Photographer: Scott Olson/Getty Images

Oct. 21 (Bloomberg) -- Thousands of brick houses line the
streets of Huber Heights, a leafy suburb of Dayton, Ohio, named
for the builder who developed it in the 1950s and nurtured its
growth. Until this year, his family was the town’s biggest
landlord, with a third of all rental housing. Now the tenants’
payments are being routed to a $9 billion hedge fund.

Magnetar Capital LLC, investigated by the Securities and
Exchange Commission for its housing bets leading up to the
property crash, acquired a rental business in January with about
1,900 properties from Charles H. Huber’s widow. In April, its
management company applied for the largest cut to property tax
assessments in the county’s history. The move could curb funding
for public schools, the police and fire departments and services
to the disabled, said Montgomery County Auditor Karl Keith.

Private-equity firms and hedge funds have bought as many as
200,000 homes across the U.S., typically in areas hardest hit by
the housing crash, to profit from soaring demand for rentals.
What makes Magnetar’s investment unique so far is its focus,
buying one in 11 homes in the Ohio suburb, magnifying its
influence over the residents and the town’s finances.

“Everyone is very concerned about being a thumbtack on a
map somewhere in a big high-rise office building,” Mark
Campbell, a Huber Heights council member, said in an interview
at City Hall. “We’re not bothered by out-of-town neighbors
coming in and investing in our community, but we’re not going to
be naïve because we work for 40,000 residents. We can’t let a
rental home take down the value of others.”

Rental Demand

Demand for rental accommodations in the U.S. has grown as
almost 8 million homes were repossessed through foreclosure or
sold for a loss since 2007, according to RealtyTrac. The
homeownership rate dropped to 65 percent in the first half of
this year, its lowest since 1998, Census data show, and may keep
falling as more owners lose their homes and slow income growth
and tight credit limit people’s ability to buy.

Last year, U.S. home prices dropped to a low of 35 percent
below their 2006 peak, triggering a wave of acquisitions from
investors trying to turn a business that’s been dominated by mom
and pop landlords into an institutional asset class resembling
the apartment industry.

Blackstone Group LP has led the stampede, spending more
than $7.5 billion on almost 40,000 properties, followed by
American Homes 4 Rent with more than 20,000. Investors have
largely targeted Phoenix; Atlanta; Dallas; Charlotte, North
Carolina; and Tampa, Florida, where growth in jobs and
population is expected to drive up rents and home values.

Huber Purchase

Magnetar, named after a neutron star with a super-powerful
magnetic field, raised $71 million in a private placement for
Huber Funding LLC, according to an SEC filing in February.
Documents from the Ohio Secretary of State show Magnetar bought
Huber Investment Corp. and other companies from Huber’s widow,
Teresa J. Huber, for an undisclosed sum. She didn’t return phone
messages seeking comment on the sale.

The hedge fund picked Huber Heights because it found a
ready-made rental company that could deliver the kind of steady
returns its investors expect, according to spokesman Tony
Fratto. Magnetar wouldn’t disclose its expected return for the
Huber investment, Fratto said. The firm had $9.1 billion under
management as of January, according to its website.

“They weren’t altering the housing mix in a community,”
said Fratto, who works for Hamilton Place Strategies in
Washington. “They weren’t disruptive. This was a business that
was already profitable and they’re making it more profitable
with good management and good technology and investments in the
properties.”

Largest Landlord

While Magnetar is a mid-tier player in the burgeoning home
rental industry, the purchase makes it the town’s largest
landlord, housing hospital employees, tool makers and federal
and civil employees of nearby Wright-Patterson Air Force Base.

Huber Heights grew after World War II along with Dayton, a
crossroads for goods made in America’s industrial heartland.
Workers for the predecessors of General Motors Co. and Delphi
Automotive Plc churned out auto parts at factories that now are
mostly shut.

Huber started to develop the town, midway between
Cincinnati and Columbus, the Ohio capital, in the 1950s. He was
building affordable homes selling for $13,995 with a $995 down
payment, according to the Ohio Historical Society. From 1956 to
1992 the builder put up 10,707 mostly brick, single-family homes
and 2,258 multifamily properties in the community, Huber Heights
Chamber of Commerce records show. The average sales price for an
existing home in August was $95,300, according to data from the
Dayton Area Board of Realtors.

Stable Values

“The property values are stable and that’s what’s
attractive,” said Fratto, a former White House and Treasury
Department spokesman during the George W. Bush administration.
“Maybe for other investors going to places like Las Vegas and
Arizona, going to hot areas works for them. That’s not
Magnetar’s style.”

The bulk purchase of Ohio residences follows a history of
sometimes controversial investments the firm has made since it
was started in 2005 by Chief Executive Officer Alec Litowitz,
the former global head of equities at Chicago-based Citadel LLC,
and Ross Laser, former president of Glenwood Capital
Investments.

In 2006 and 2007, the hedge fund helped create more than 20
financial instruments called collateralized debt obligations
that were named after constellations. The CDOs, which pooled
mortgage bonds and sliced them into securities of varying risk,
totaled at least $32 billion.

Magnetar Strategy

Magnetar’s strategy involved buying the riskiest pieces of
the securities and simultaneously making larger bets that less
risky portions would fail. The firm wagered correctly that if
subprime borrowers defaulted and housing declined, then the
value of even the safest CDO pieces would suffer.

JPMorgan Chase & Co., which allegedly marketed some of the
securities without disclosing Magnetar’s role in structuring the
deals, agreed to pay $153.6 million in June 2011 to settle an
SEC investigation, without admitting wrongdoing. The SEC hasn’t
filed a complaint against Magnetar.

In another deal, called Octans I, Magnetar invested in the
equity portion of the CDO and then helped select the subprime-mortgage bonds. The manager of the transaction, Wing F. Chau,
knew Magnetar’s strategy’s was also to short, or bet against
other parts of CDOs, according to the SEC, which last week
accused Chau of misleading investors by accommodating Magnetar’s
request without telling the investors. Magnetar picked bonds
that credit analysts at Chau’s firm Harding Advisory LLC
disfavored, the SEC said. Steven Molo, a lawyer for Chau, didn’t
return phone calls seeking comment.

Market Neutral

The hedge fund told its investors in 2010 that it offered
limited input on the creation of CDOs, and made bets that would
pay off if they soured as part of a “market neutral” portfolio
designed to profit no matter what happened.

Magnetar learned the Huber business was for sale from
Vinebrook Partners LLC, a real estate investment and management
firm that was operating about 400 single-family rental
properties in nearby Cincinnati and Indianapolis. Vinebrook,
based in Lexington, Massachusetts, is overseeing the Huber homes
for Magnetar.

Assessment Appeal

On April 1, the new property managers asked to have the
assessed value on 1,218 residences in Montgomery County cut by
49 percent, to $50 million from $98.6 million, according to
Keith, the county auditor.

Vinebrook co-founder Daniel Bathon, a former Drexel Burnham
Lambert Inc. investment banker, said the tax cut will help them
invest more in the properties, which will increase their
attractiveness and value over time.

“We’re going to improve the resident base for the town,
which I think is a big asset to the community,” he said in a
telephone interview from Huber Heights.

The assessments, based on a combination of comparable sales
and estimates of cash flow from income properties, are
considered fair market values, so resale amounts are lower if
they go down, Keith said. The reassessments could influence
surrounding property values, if local homeowners follow suit.

“Other property owners might look at those and see those
as evidence their properties are worth less,” Keith said.

Granting the appeal would reduce property tax collections
by $1.39 million, including as much as about $800,000 to Huber
Heights City Schools, equivalent to about 16 teaching positions,
and curb financing for community colleges, police, fire,
libraries and services to the disabled, according to Keith.

‘Resident Base’

Before selling the company, the former owner had begun the
process of appealing tax assessments for about 300 of the units
in the county, according to Vinebrook.

Ohio requires a countywide reassessment every three years.
In the last one, in 2011, values fell 7 percent, or about $2
billion in Montgomery County. Magnetar is now the county’s
sixth-largest property owner after Dayton Power & Light, the
city of Dayton, Miami Valley Hospital, Montgomery County Board
of Commissioners and the U.S. government. The government
entities don’t pay property taxes, according to Keith.

The sale of the Huber homes to an institutional investor
“will affect the quality of the area more than anything else,”
said Charles’s brother Donald Huber, 81, who built houses in
another part of town. “It’s a local business. We always tried
to maintain a quality image and spent probably more money than
we should have to do that. I don’t see anybody who’s interested
in next quarter’s earnings doing that.”

Residents’ Lives

While the value of the hedge fund’s CDO investments was
tied to cash flow from homeowners making mortgage payments, the
securities were bought and sold by sophisticated financial
institutions. This time, through its management company, the
strategy influences the lives of residents living in a
quintessential suburban town, where earlier this month kids rode
bicycles as autumn leaves fell along tree-lined streets and
music played from an ice cream truck in the distance.

Charles Huber, who died at age 79 in 2003, fostered the
town’s expansion, building the first private utility company in
the state of Ohio and donating land for several public schools.

The Huber Heights school district, which gets about half of
its $58.4 million operating budget from property taxes, has
filed to block the reassessments, as they will “significantly
impact us,” said Superintendent Susan Gunnell.

School Cuts

State and local funding cuts since 2009 already forced the
district to shrink its staff by 30 percent -- 226 positions,
including 100 teachers -- according to Gunnell.

Art, choir, Advanced Placement and physical education
classes have been reduced or canceled while janitors, bus
drivers and teachers’ aides were laid off. Math test scores fell
last year, a product of budget cuts and new state standards that
teachers with limited resources were ordered to adopt, Gunnell
said.

“I’m a firm believer that the schools and community are
very much intertwined,” Gunnell said. “Good schools build good
communities and good communities build good schools. If you want
families to continue to move into the community, they’re going
to be looking at how the schools are doing.”

Knowing the potential tax cut would affect the community,
Bathon said he spoke in advance with the mayor and vice mayor
and asked for a meeting with the school board.

“We said, ‘Look, we know this will be a hit. We want you
to be able to plan for it, but if we do this it will help add to
the investment we can make in the properties to improve them and
get them up higher values in the long-run,’ and of course that’s
great for the town and the schools and for us as well,” said
Bathon.

School Donation

He told officials in a meeting at City Hall last week that
Vinebrook was going to donate $25,000 to help staff a police
officer at one of the city schools and that it planned to make
at least $1 million in improvements to its units in fiscal 2013
and 2014. That’s an average $674 per property if the entire
investment goes into the town’s homes.

Huber Heights, which incorporated as a city in 1981, has
15,875 housing units, according to 2010 Census data. About 28
percent are rentals.

Monthly rent for a Huber home ranges from about $500 to
$1,500, according to Amy Logan, head of leasing, who also worked
for the prior management company. The occupancy rate is about 90
percent in the homes, some of which are multifamily units or
apartments.

“Many are under market, so there’s room to raise the
rents,” Logan said.

Lowest Rent

Jennifer Wright, a 31-year-old quality control specialist
for Community Tissue Services, has been living in a Huber home
with her two kids for five years. She said she’s only stayed
because her $785 monthly rent is the lowest she can find in
town.

“I’ve looked every year for the last six,” Wright said.
“Everybody wants over $800 a month for a three-bedroom, two-bath.”

Paul Hubbs, 42, pays $575 a month to lease a three-bedroom,
one-bathroom bungalow. Rent has gone up $10 a year in the past
four, said Hubbs, who works at an area toolmaker, and his
payment was always $40 less if he paid before the start of the
month.

Huber Heights is counting on the new landlord to put money
back into the community. City officials are designating
reinvestment areas to entice Vinebrook to renovate older
properties and boost the community’s value.

Investor Returns

“If they’re going to show return back to the investors,
they need to yield the most rent they can and increase the
values of those homes,” said Campbell, who is also the vice-mayor.

The majority of companies building large-scale rental
businesses are buying foreclosures at auctions, properties
through short sales or on the open market. The investment firms
are scouring for areas to buy amid the biggest increase in home
prices in seven years. The S&P/Case-Shiller index of property
values in 20 cities increased 12.4 percent in July from a year
earlier, the biggest advance since February 2006.

While activity has been focused in California, Arizona,
Georgia and Florida, parts of the Northeast and the Midwest are
emerging as attractive areas for institutional investors,
according to Morgan Stanley analyst Haendel St. Juste. The bank
estimates the homeownership rate will stabilize around 63
percent, which means more than 2 million households will go from
being owners to renters. The institutional buy-to-rent industry
could grow six-fold in the next few years to a more than $100
billion market opportunity, St. Juste estimates.

Property Values

Magnetar has bought in a region where property values are
still falling. According to the Dayton Area Board of Realtors,
the median existing home sales price in September in the area
was $106,450, down 2.3 percent from the same month in 2012.

“Ohio in general has been a slow-growing economy at best
and the housing market has been perennially soft,” said Mark
Zandi, chief economist for Moody’s Analytics Inc.

The investment firm’s concentrated, mass purchase comes
with advantages. Most of the Huber homes are contained within
22.4 square miles (58 square kilometers). That’s a benefit when
landlord profits depend on finding efficient ways to operate
scattered-site properties that have their own lawns and roofs.

Some Huber Home Rental employees said they already see a
change for the better. Logan, Vinebrook’s head of leasing,
described the new management as “very involved” and
“efficient.”

“It was nerve-racking, when a company comes in and buys a
company like this,” she said. “I see improvements already.”

Modernizing Company

Bathon said Vinebrook is modernizing the company, which was
run mostly on paper, and making improvements to quality of the
carpet, paint, kitchens, bathrooms and fixtures in homes.

“We believe that will increase occupancy more,” he said.
“It will lower turnover -- turnover is a big expense in our
business. It will allow us to charge more appropriate rents
long-term.”

Bathon said he goes to Huber Heights “every single week,”
to work with tenants, vendors, and the town.

“I’ve made significant efforts to make myself known, to
make our plans known, to add transparency to a company that
probably didn’t have that history prior,” he said.

For the family who developed and nurtured the town,
donating land, fire trucks and drug dogs for the police force,
their legacy might be lost, according to Donald Huber.

“You don’t have anybody like Charles that lived in the
area, knew the people, was willing to put money into maintaining
the quality of the community, and had a legacy he was interested
in maintaining,” he said. “That is not part of the equation
anymore.”